Methods of Valuation for Mergers and Acquisitions

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This can happen through absorption of an existing company by another. In a consolidation, which is a form of merger, a new company is formed to takeover existing business of two or more companies. In India, mergers are called amalgamations in legal parlance. The acquisition refers to the acquisition of controlling interest in an existing company. A takeover is same as acquisition, except that a takeover has a flavor of hostility in majority of cases.

For this reason, the company taken over is usually called the target company and the acquirer is called the predator. The mergers are different from acquisitions in the sense that acquisitions generally do not involve liquidation of the target company.

Methods of Valuation for Mergers and Acquisitions

Why Mergers and Acquisitions take place? Objective for Companies to offer themselves for sale? Sections to deal with the procedure, powers of the court and allied matters. There is also a cost attached to an acquisition. The cost of acquisition is the price premium paid over the market value plus other costs of integration.

Therefore, the net gain is the value of synergy minus premium paid. If the premium paid for this merger is Rs. It is this 30, because of which companies merge or acquire.


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Analysts use a wide range of models in practice for measuring the value of the Target firm. These models often make very different assumptions about pricing, but they do share some common characteristics and can be classified in broader terms.


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There are several advantages to such a classification: it is easier to understand where individual models fit into the bigger picture, why they provide different results and where they have fundamental errors in logic. There are only three approaches to value a business or business interest. However, there are numerous techniques within each one of the approaches that the analysts may.

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The Approaches and Techniques are as follows: -. Income Approach The Income Approach is one of three major groups of methodologies, called valuation approaches, used by appraisers.

Valuation for Mergers and Acquisitions, Second Edition

It is particularly common in commercial real estate appraisal and in business appraisal. The fundamental math is similar to the methods used for financial valuation, securities analysis, or bond pricing. However, there are some significant and important modifications when used in real estate or business valuation. The Discounted Cash flow valuation is based upon the notion that the value of an asset is the present value of the expected cash flows on that asset, discounted at a rate that reflects the riskiness of those cash flows.

The nature of the cash flows will depend upon the asset, dividends for an equity share, coupons and redemption value for bonds and the post tax cash flows for a project.

5. Valuation Methods: An Overview | Valuation for Mergers and Acquistions: An Overview | InformIT

The Steps involved in valuation under this method are as under:. Step I: Estimate free cash flows available to all the suppliers of the capital viz. Step II: Estimate a suitable Discount Rate for acquisition, which is normally represented by weighted average of the costs of all sources of capital, which are based on the market value of each of the components of the capital. T is the marginal tax rate. Step IV: Estimate the Terminal Value of the business, which is the present value of cash flows occurring after the forecast period. This will give the value of firm. Step VI: Subtract the value of debt and other obligations assumed by the acquirer to arrive at the value of equity.

The Capitalized Cash flow technique of income approach is the abbreviated version of Discounted Cash flow technique where the growth rate g and the discount rate k are assumed to remain constant in perpetuity. The origin of market approach of business valuation is established in the economic rationale of competition. It states that in case of a free market, the demand and supply effects direct the value of business properties to a particular balance. The purchasers are not ready to pay higher amounts for the business and the vendors are not ready to receive any amount, which is lower in comparison to the value of a corresponding commercial entity.

It the value of a firm by performing a comparison between the firms concerned with organizations in the similar location, of equal volume or operating in the similar sector. It has a large number of resemblances with the comparable sales technique, which is generally utilized in case of real estate estimation. The market value of shares of companies that are traded publicly and are involved in identical commercial activities may be a logical signal of the value of commercial operation. In this case the company shares are bought and sold in an open and free market.

This process allows purposeful comparison of the market value of shares. The problem exists in distinguishing public companies, which are adequately corresponding to the company concerned for this intention. In addition, in case of a private company, the liquidity of the equity is lower put differently, its shares are difficult to trade in comparison to a public company. The value is regarded as somewhat lesser in comparison to that a market-based valuation will render.

Considering the circumstances,. The first step in using the assets approach is to obtain a Balance Sheet as close as possible to the valuation date.

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Each recorded asset including intangible assets must be identified, examined and adjusted to fair market value. Now all liabilities are to be subtracted, again at fair market value, from the value of assets derived as above to reach at the fair market value of equity of the business. It is important to note here that any unrecorded assets or liabilities should also be considered while arriving at the value of business by the assets approach.

Net asset value NAV is a term used to describe the value of an entity's assets less the value of its liabilities. The term is most commonly used in relation to open-ended or mutual funds due to the fact that shares of such funds are redeemed at their net asset value. Investors might believe that the company has significant growth prospects, in which case they would be prepared to pay more for the company than its NAV.

For valuation purposes it is common to divide net assets by the number of shares in issue to give the net assets per share. This is the value of the assets that belong to each share, in much the same way that PE Ratio measures profit per share. Net worth of the company would be Rs. NAV can also be calculated by adding all the assets, and then subtracting all the outside liabilities from them. This will again boil down to net worth only.

One can use any of the two methods to find out NAV. Economic Value Added or EVA is an estimate of economic profit, which can be determined, among other ways, by making corrective adjustments to GAAP accounting, including deducting the opportunity cost of equity capital.

The concept of EVA is in a sense nothing more than the traditional, commonsense idea of "profit," however, the utility of having a separate and more precisely defined term such as EVA or Residual Cash Flow is that it makes a clear separation from dubious accounting adjustments that have enabled businesses such as Enron to report profits while in fact being in the final approach to becoming insolvent. Another, much older term for economic value added is Residual Cash Flow. One will have to select the comparables carefully reflecting industry trends, business risk and market growth so that the result is near to perfection.

However, one needs to be cautious of the fact that no two companies are perfectly similar and the valuations may not be identical. Similarly, discounted cash flow technique is not so much influenced by market conditions or non-economic factors. In fact, it is the most powerful method of valuation if one is confident in the projections and assumptions as DCF values the individual cash streams directly.

The valuation obtained is very sensitive to modeling assumptions—particularly growth rate, profit margin, and discount rate assumptions. So, different DCF analyses can lead to various different valuations. In valuation done by the DCF technique, forecasting of future performance thus becomes the key. The precedent transaction is often vouched as the best valuation as the previous transaction has validated the valuation.

However, one has to keep in mind that the valuation multiples in prior transactions will include premium and synergy assumptions, which may not be public knowledge most of the time. Have any question on it? Write down in the comment box below, I would love to answer. Very informative and crisp article. Great article on transactions. Thanks for your kind feedback! Only fill in if you are not human.

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